Environmental regulation

The irony of the tragedy of the commons

THE American Economic Review just turned 100. It turns out that the original issue in 1911 featured an article by Professor Katharine Coman of Wellesley College entitled “Some Unsettled Problems of Irrigation”, and in the anniversary issue, Robert Stavins (via Mark Thoma) cleverly decides to retrace what's happened since then with economic theory on "commons problems". Basically, he writes, Pigou and Coase and those who followed them have done yeoman work that's led to the institutionalisation of tools like cap-and-trade allowances for fishing permits and pollution permits, which are superior to command-and-control rules both from an environmental and economic perspective:

First, economic theory—by focusing on market failures linked with incomplete systems of property rights—has made major contributions to our understanding of commons problems and the development of prudent public policies. Second, as our understanding of the commons has become more complex, the design of economic policy instruments has become more sophisticated, enabling policy makers to address problems that are characterized by uncertainty, spatial and temporal heterogeneity, and long duration. Third, government policies that have not accounted for economic responses have been excessively costly, often ineffective, and sometimes counterproductive.

For example, he writes, the 1990 law establishing tradable permits to bring down sulfur dioxide emissions rather than using command-and-control regulations saves the economy $1 billion a year. And with what he calls the "ultimate problem of the commons", greenhouse gases, "there is widespread agreement among economists (and a diverse set of other policy analysts) that economy-wide carbon pricing will be an essential ingredient of any policy that can achieve meaningful reductions of CO2 emissions cost effectively, at least in the United States and other industrialized countries (Gilbert E. Metcalf 2009; Louis Kaplow 2010). The ubiquitous nature of energy generation and use and the diversity of CO2 sources in a modern economy mean that conventional technology and performance standards would be infeasible and—in any event—excessively costly (Newell and Stavins 2003)."

The problem with this picture is passed along by Dave Roberts at Grist. The public, according to a new poll, does want to cut CO2—and smog, and mercury. But they want to do it through EPA regulation, ie command-and-control, not tradeable permits or Pigovian taxes.

I've never seen a behavioural economics study on this, but I'm sure somebody's done it, because it seems pretty widespread: people generally prefer rules telling them something is not allowed, rather than charges making them pay for it, even if the latter are clearly more efficient at maximising social value. Mr Stavins does recognise this, observing that in terms of political appeal, aversion to the word "taxes" is probably one reason why cap-and-trade systems for carbon emission permits have already been instituted in Europe; but he also notes that "now that cap and trade has been demonized—in US politics, at least—as 'cap and tax,' this difference has surely diminished."

The darkly ironic side of all this, of course, is that administrative command-and-control solutions like detailed EPA emissions rules are definitely more expensive than cap-and-trade or carbon taxes would be. If anything, when the public votes for EPA regulation rather than cap-and-trade, that's when it's imposing a tax on itself. Fifty years after Coase and 90 after Pigou, the economists are pretty sure they've finally got the solution for fixing commons problems without diminishing social value, only to have the public reject it because they think that's the tax. If the tragedy of the commons is "Romeo and Juliet", the rejection of Coasian cap-and-trade solutions to commons problems is "Blood Simple": a hilariously bitter demonstration of the human capacity for selfish stupidity that ends with the only guy who's figured it all out getting shot through a door by the wrong person for the wrong reasons.

I can see why people feel the way they do. If it's wrong, it's wrong for everyone. Don't tell me that if some guy has enough money, it's not wrong for him. If you can buy your way to abuse of the commons, it's not really the commons anymore.

"I've never seen a behavioural economics study on this, but I'm sure somebody's done it, because it seems pretty widespread: people generally prefer rules telling them something is not allowed, rather than charges making them pay for it, even if the latter are clearly more efficient at maximising social value"

I haven't done research at this either, but there's a niggling doubt I've always had about economics that I think explains it.

The problem with economic thinking and the price signal is that it selects heavily in favor of people that think in terms of what's communicated by price in favor of those that take other things into account. So you go further in your career if you think about maximizing your income and less about how this is costing you time with your 2 year old kid. More broadly, it encourages society to choose to maximize those things that can be communicated by price, and to minimize those things that can't be communicated easily by price, like mercury in the water.

This kicks in with policies like this. We're taught to basically ignore things like rules when it comes to min/maxing behavior. It's just part of the background and not something that we need to consider, so we discount it to zero. After all, if making an economic transaction between businesses if there's no tax on mercury emissions I'll be worse off economically if I take it into account, and probably go out of business. So the price of the regulation goes to zero in our heads, because this is what we'd be rewarded for if we were making a transaction in the market, and not acting politically.

Talking about a tax triggers that market thinking again. All of a sudden restricting mercury missions goes from free to costly, since if we were using our market instincts we pay for the tax where the rule is just background that's not monetized. So our instincts, highly trained by daily market interactions, signal one as a price to be min/maxed and the other as just noise that we can ignore.

Intellectually of course we can figure this out. But if a voter is on the fence about the policy already, this emotional response can push them one way or the other at the margins. Overcoming this is certainly possible on an individual level but in aggregate it's harder to get people to suspend this thinking to price both when only one thing would be a price in a private transaction and the other would be something externalized and free to those making the transaction (if the policy weren't binding on people, in other words, I'm suggesting it's a problem with code switching since in a private transaction we only pay attention to the monetized costs and not the non-monetized costs while in a political situation we're discussing about whether to monetize something that was previously cost free which is only possible in a political conversation and not (easily or commonly) in the private market).

Well obviously the public doesn't want there to be a carbon market; that's socialism. Better that the federal government just create stacks of regulations that direct the operation of a major sector of the economy.

I always get confused when I advocate an offset carbon tax as a response to global warming by the political orientation of the people who are opposed to it - namely free market conservatives who believe something should be done to reduce carbon emissions/energy usage.

While taxes seem like a very non-free market solution, it's about as good as it gets. It eliminates activities that pollute a lot for little economic benefit, while preserving activities that have a high return on value for pollution. As a consequence, it also makes low-pollution energy sources more viable. Most importantly, it does so without any decision-making by the government about WHAT those activities or energy source are; that's left to the market.

Obviously, taxes are not a small-government thing, but the revenue from the tax isn't what makes it effective, rather it's the cost gradient on polluting activities that matters - the revenue can be returned, through cuts to other taxes, without impacting the effectiveness of the tax. Now, my econ major friend has warned me that taxes slow down economic activity beyond their revenue gains, which is a fair point, but would a carbon tax do so more than income taxes? Corporate taxes? Payroll taxes? I don't think so, at least not appreciably.

The only cost is in the disruption of established economic activity, from the high-polluting to the low polluting. That's not insignificant - shifting resources and people away from say coal mining to windmill repair (just an example) isn't easy. But to achieve lower emissions, regardless of method, that transition is going to happen anyway. Otherwise, a revenue-neutral carbon tax is the most free-market way to approach carbon emissions and is only minimally economically damaging!

I once worked for a Democratic politician. In the context of some regulation, I suggested a Pigovian tax. I was told "No, I don't want them to be able to pay their way out of it. I want it banned." I think a large segment of the population believes if something shouldn't be done, it should be banned outright and that things like cap-and-trade and Pigovian taxes are still letting the wrongdoers off too easy. Taxes don't carry moral condemnation. I think it may be because they see business activity less as economic decisions and more as moral ones. Does anyone think that if we had a high carbon tax, people would stop calling for a reining in of gas guzzlers? This is primarily problem on the left. The right's problem is that they aren't thinking about the political reality. If you close the door to Coasian bargaining, you're gonna get bad regulations.

It's possible to explain to people why a carbon tax or cap-and-trade are far superior to command-and-control. The problem is all the noise, created mostly by those who do not want to have to account for their own externalities.

It may be that the route we eventually take is this: EPA regulation of carbon emissions is established to the point where interested parties no longer think that they can avoid the regulation (and we'll imagine we live in a world without agency capture). Suddenly, because command-and-control really is inefficient, interested groups will start to favor more market-oriented solutions like cap-and-trade or a carbon tax.

At least this could happen. If it does, it will show a rather unfortunate route for economists to take in policy matters: advocate for command-and-control, to the extent this is more acceptable for whatever behavioral reasons, and then hope that the relevant interest groups eventually lobby for the less-inefficient tax solution.

Yeah, probably won't work will it. Too much incentive for the regulated entities to capture their regulators, so that captured command-and-control is better for them than a straight tax. But whatever, it's probably more likely to actually work out this way than for the general populace to suddenly support the "I see a negative externality, let's tax it!" way of thinking.

Speaking of Coase, I've been thinking about him recently. But "The Nature of the Firm", not "The Problem of Social Cost." All this labor union talk has had me trying to address a fundamental concern: organized capital and labor using their resources to distort the market, whether through the direction acquisition of monopoly power or through lobbying, regulatory capture and the like.

If a chief advantage of firms (organized capital) is that they lower transaction costs, is there hope that technological advances will continue to lower transaction costs, allowing for more distributed production and reducing the advantages of scale that many firms enjoy? I don't know if this has been happening. Are more people in business for themselves than in the past, and are the largest firms smaller as a percentage of the economy than they once were?

Thanks for the recognition, though usually when I post things it's something I actually know something about and could cite data on if I had to. I have no idea if this thought would hold up to any scrutiny or if it's a bunch of BS based on too little data and trying to force a pattern on it. It's a thought that's been rattling round in my head for a while due to separate issues and this reminded me of it. Would it hold with a few more data points, or is it based on just not knowing what I'm talking about? I don't know, I don't have enough data to be confident about my claim. Hence just a thought.

@ bampbs: "If it's wrong, it's wrong for everyone. Don't tell me that if some guy has enough money, it's not wrong for him. If you can buy your way to abuse of the commons, it's not really the commons anymore."

This points to a conundrum that I see in the theory behind economics. Given a bunch of people who all have equal means, I think that most people would agree that it makes sense for the person who is willing to give up the most to get something to be the person who gets it. In this case markets really are not only the most efficient but the most moral way of allocating resources, since each person gets the goods that they have demonstrated that they care most about.

The problem is, though, that people don't all have equal means. I might really, really want a gas guzzling car and be willing to commit most of my resources to getting one, but if I don't have enough resources at my disposal then the car will instead go to a rich person who only has to commit 0.0001% of their resources. It would be one thing if anyone was practically guaranteed to become arbitrarily rich given an arbitrary amount of effort, but this is simply not the case and is likely never to be the case. Thus, in practice, markets don't actually distribute each good to the person who cares most about it but instead they distribute a large proportion of goods that are strongly wanted by many to a lucky few who actually don't care that much about them, which destroys what to me is a basic premise behind why markets could be consider to be the most moral way of allocating resources.

A carbon market "saves the economy $1 billion a year" only if the only alternative is expensive government regulation. This is like saying that invading Iraq saved $500 billion a year because the alternative was invading the entire Middle East.

Also $1 billion seems a piddling amount in comparison to the economic disruption of either program. Even if there are great strides in addressing the tragedy of the commons, how much of that would survive the inevitable horse-trading in the transition to law?

Turkey Vulture: if you’re brave enough to take “The Nature of the Firm” to its bizarre conclusion, you might be interested in Coasian Polity Markets.

If the state were subject to voluntary incorporation in the same way that “private” firms are, then competition in the polity market would promote an optimal level of state planning (an inversion of the reasoning in footnote 14 of “The Nature of the Firm”).

The meta-constitutional procedures for doing this may be modelled on the statutory remedies for "oppression of minorities" found in modern corporations law.

Some might go so far as to suggest that this would eliminate the [historically very recent] distinction between “public” and “private”. The fundamentalist Libertarians could then climb down from their pulpits and get a job like everyone else.

Meant "market power" rather than "monopoly power" in the first paragraph there. After a semester of Antitrust it doesn't seem like I'd make that mistake, but I guess I really do dump everything I learn after I finish my finals.